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Post: The Big Move: I’m selling a home with a vacant lot, but my buyer can’t get a loan to cover everything. Should I let him pay me in installments?

Dear MarketWatch,

I own a home with a vacant lot attached to it. They are separate properties for tax purposes and can be sold as separate entities. I have a potential buyer for both my home and the vacant lot.

The potential buyer will be able to qualify for a mortgage covering the amount of the home, but not for the amount of the house plus the vacant lot. He has suggested beginning to give me money towards the vacant lot until it is paid for.

Is there a way to do this legally that will not cause me to pay additional income tax or cause the bank to red flag me to the IRS for large deposits to my account?


Vexed about My Vacant Lot

The Big Move’ is a MarketWatch column looking at the ins and outs of real estate, from navigating the search for a new home to applying for a mortgage.

Do you have a question about buying or selling a home? Do you want to know where your next move should be? Email Jacob Passy at TheBigMove@marketwatch.com.

Dear Vexed,

I can imagine how stressful your situation is. Here you were, you thought you found the perfect buyer, but then things got complicated. This likely goes without saying, but I hope you’re still exploring all of your options for this property and aren’t simply settling for this buyer. I’ll assume your real-estate agent can’t get you a better deal — and that they figured your best bet was to sell the two properties together rather than as separate entities.

In any case, my best guess would be that the mortgage lender your buyer is working with only approved him for purchasing a single property. And in their view, because the vacant lot was kept separate for tax purposes, the loan’s proceeds couldn’t be used to purchase it as well.

I want to assuage some of your concerns right off the bat. The arrangement your buyer has proposed is common, and it actually can have tax benefits to you.

Essentially this would be an installment sale, because you wouldn’t be receiving payment for the vacant lot in one fell swoop. Presuming it takes the buyer more than a year to pay you, it would be considered an installment sale in the eyes of the IRS.

The capital gains on the sale of that parcel of land, therefore, can be spread out over time. An installment sale may also prevent you from entering another tax bracket, wrote Michael Bowman a partner in the Las Vegas office of Anderson Law Group, a national law firm, in a blog post.

“The sale of some sizable property or property of sizable value — whether it’s commercial real estate or residential real estate — can bump an investor into a tax bracket they’d like to avoid,” Bowman wrote. “An installment sale allows real estate investors to pace out their income so that it isn’t associated with taxes that may pose a risk to the future of their business.”

There are other benefits aside from the tax savings. You’ll skip some of the closing costs that might otherwise come into play, and as you’ve already seen, it can help make the deal close quicker.

You should also plan to charge interest on the property, given that you’re not being compensated immediately. How much you charge is your decision.

This doesn’t mean that such an arrangement isn’t without risks though. I don’t know how your real-estate agent plans to structure the sale, but it’s possible that there would be two separate transactions, one for the home and one for the vacant lot.

When it comes to the vacant lot, you would essentially be financing the deal yourself because the buyer isn’t paying you the full amount at once.

“A seller financing agreement functions along similar lines as a mortgage loan, except that it cuts out the middleman and allows the home seller to own and oversee the debt instead of a traditional lender,” Rocket Mortgage

notes. In other words, when it comes to the vacant lot, you’d be acting like a mortgage lender.

A seller-financed deal can take many forms: A land contract, an assumable mortgage, a rent-to-own contract, etc. I won’t get into the specifics of each of these different types of deals, but it’s clear to see that it can get complicated.

The biggest risk is that your buyer falls on financial hard times and finds himself unable to keep making payments to you for the parcel of land. You’ll want to ensure that your rights in such a situation are protected by the sales agreement you both sign.

These arrangements also exist in a bit of a gray area, since essentially both of you will have a stake in the property. Here’s why that matters: Let’s say you sell the lot to him and he builds a guest house on it, but down the road he stops making his payment. You can likely foreclose on him, but then you’re no longer left with a vacant lot. That will affect your ability to resell it.

So when you draw up the agreement, be sure to spell out what the buyer can and cannot do with the property while he still owes you money. Given the complexities of this situation, you should strongly consider hiring a real-estate attorney who is familiar with this type of deal, as well as an accountant who can help you to strategize your finances to ensure you reduce your tax liability. Doing that will give you more assurance that you won’t lose money on this deal.

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